Taxation of Individuals and Business Entities 2019 Edition Chapter 2 Tax Compliance, the IRS, and Tax Authorities

Learning Objectives (1 of 2) Identify the filing requirements for income tax returns and the statute of limitations for assessment. Outline the IRS audit process, how returns are selected, the different types of audits, and what happens after the audit. Evaluate the relative weights of the various tax law sources. Describe the legislative process as it pertains to taxation.

Learning Objectives (2 of 2) Perform the basic steps in tax research. Describe tax professional responsibilities in providing tax advice. Identify taxpayer and tax professional penalties.

Taxpayer Filing Requirements Corporations: all must file regardless of taxable income Estates and Trusts: required to file if gross income exceeds $600 Individuals: filing is determined by taxpayer’s filing status, age, and gross income

EXHIBIT 2-1 2018 Gross Income Thresholds by Filing Status (1 of 2) Filling Status and Age (In 2017) 2018 Gross Income Explanation Single $12,000 $12,000 standard deduction Single, 65 or older $13,600 $12,000 standard deduction + $1,600 additional deduction Married, filing a joint return $24,000 $24,000 standard deduction Married, filing a joint return, one spouse 65 or older $25,300 $24,000 standard deduction + $1,300 additional deduction Married, filing a joint return, both spouses 65 or older $26,600 $24,000 standard deduction + $2,600 additional deduction (2) Married, filing a separate return $0

EXHIBIT 2-1 2018 Gross Income Thresholds by Filing Status (2 of 2) Filling Status and Age (In 2017) 2018 Gross Income Explanation Head of household $18,000 $18,000 standard deduction Head of household, 65 or older $19,600 $18,000 standard deduction + $1,600 additional deduction Surviving spouse with a dependent child $24,000 $24,000 standard deduction Surviving spouse, 65 or older, with a dependent child $25,300 $24,000 standard deduction + $1,300 additional deduction

Tax Return Due Date Individuals: 15th day of 4th month following end of tax year C corporations: Generally 15th day of the 4th month following end of tax year Partnerships and S corporations: 15th day of 3rd month following end of tax year Due dates on a Saturday, Sunday, or holiday are extended to next business day. Individuals, corporations, and partnerships are allowed to apply for automatic extensions.

Return Due Date Examples Corporation XYZ, Inc. has a tax year which ends on August 31st. When will their tax return be due? December 15th Assume they filed an extension, when would the tax return be due? June 15th

Statute of Limitations Often, tax returns are filed with incorrect amounts reported either in the taxpayer’s favor or the government’s favor. Statute of limitations: the time in which the taxpayer can file an amended return or the IRS can assess a tax deficiency Generally ends 3 years from the later of (1) the date the tax return was actually filed or (2) the tax return’s original due date

Statute of Limitations Example Bill and Mercedes file their 2014 federal tax return on September 6, 2015, after receiving an automatic extension to file their return by October 15, 2015. When does the statute of limitations end for their 2014 tax return? September 6, 2018 (3 years after the later of the actual filing date and the original due date)

IRS Audit Selection In general a taxpayer’s return is selected for audit because the IRS believes the tax return has a high probability of being incorrect. IRS uses computer programs to identify tax returns which might have an understated liability. Discriminant Function (DIF) system (scoring system) Document perfection (checks for math errors, etc.) Information matching programs (compares tax return data with other IRS information)

Types of Audits Correspondence examinations Office examinations Most common audit Conducted by mail and are generally limited to 1 or 2 items on the return Office examinations Second most common audit Conducted in the local IRS office and tends to be broader in scope Field examinations Least common audit Held at the taxpayer’s place of business and can last months to years

EXHIBIT 2-2 IRS Appeals/Litigation Process

Trial Level Courts U.S. Tax Court U.S. District Court National court; Tax experts; Do not pay tax first U.S. District Court Local court; Possible jury trial; Generalists; Pay tax first U.S. Court of Federal Claims National court; Generalists; Pay tax first; Appeals to U.S. Circuit Court of Appeals for the Federal Circuit

EXHIBIT 2-3 Federal Judicial System U.S. Supreme Court U.S. Circuit Courts of Appeals (1st–11th Circuits and D.C. Circuit) U.S. District Courts U.S. Tax Court U.S. Tax Court Small Claims (No Appeal) U.S. Circuit Court of Appeals (Federal Circuit) U.S. Court of Federal Claims

U.S. Circuit Courts of Appeal (1 of 2) EXHIBIT 2-4 Geographic Boundaries for the U.S. Courts of Appeal

U.S. Circuit Courts of Appeal (2 of 2) Source: www.uscourts.gov/courtlinks *U.S. District Court jurisdictions for those states with more than one U.S. District Court are also depicted (for example, the state of Washington is divided into Eastern and Western Districts). †Not depicted are the U.S. Circuit Court of Appeals for the District of Columbia and the U.S. Circuit Court of Appeals for the Federal Circuit.

Tax Law Sources Primary Authorities: Official sources of tax law Statutory sources (e.g., Internal Revenue Code) Judicial sources (the courts) Administrative sources (IRS pronouncements) Secondary Authorities: Unofficial tax authorities Tax services Tax articles

Primary Tax Authorities (1 of 5) EXHIBIT 2-5 Citations to Common Primary Authorities Statutory Authorities: Citation: Explanation: Internal Revenue Code IRC Sec. 162(e)(2)(B)(i) Section number 162, subsection e, paragraph 2, subparagraph B, clause i Committee Reports: Senate Finance Committee Report S. Rep. No. 353, 82d Cong., 1st Sess. 14(1951). Senate report number 353, Congress number 82, Congressional session 1, page number 14, year 1951 House Ways and Means Committee Report H. Rep. No. 242, 82d Cong., 1st Sess. 40 (1951) House report number 242, Congress number 82, Congressional session 1, page number 40, year 1951

Primary Tax Authorities (2 of 5) Administrative Authorities: Citation: Explanation: Final Regulation Reg. Sec. 1.217-2(c)(1) Type of regulation (1 = income tax), code section 217, regulation number 2, paragraph number c, subparagraph number 1 Temporary Regulation Temp. Reg. Sec. 1.217-2(c)(1) Same as final regulation Proposed Regulation Prop. Reg. Sec. 1.217-2(c)(1) Revenue Ruling Rev. Rul. 77-262, 1977-2 C.B. 41 Ruling number 77-262 (262nd ruling of 1977), volume number of cumulative bulletin 1977-2, page number 41 Revenue Procedure Rev. Proc. 99-10, 1999-1 C.B. 272 Procedure number 99-10 (10th procedure of 1999), volume number of cumulative bulletin 1999-1, page number 272 Private Letter Ruling PLR 200601001 Year 2006, week number 01 (1st week of 2006), ruling number 001 (1st ruling of the week) Technical Advice Memorandum TAM 200402001 Year 2004, week number 02 (2nd week of 2004), ruling number 001 (1st ruling of the week)

Primary Tax Authorities (3 of 5) Judicial Authorities: Citation: Explanation: U.S. Supreme Court Comm. v. Kowalski. 434 U.S. 77 (S. Ct. 1977) Volume 434 of the United States Reporter, page 77, year 1977 Comm. v. Kowalski. 98 S. Ct., 315 (S.CL. 1977) Volume 98 of the West court reporter, page 315, year 1977 Comm. v. Kowalski. 77-2 USTC par. 9,748 (S. Ct., 1977) Volume 77-2 of the CCH court reporter, paragraph 9,748, year 1977 Comm. v. Kowalski. 40 AFTR2d 77-6128 (S. Ct., 1977) Volume 40 of the RIA AFTR2d court reporter, paragraph 77-6128, year 1977  U.S. Circuit Court of Appeals Azar Nut Co. v. Comm., 931 F.2d 314 (5th Cir., 1991) Volume 931 of the West F.2d court reporter, page 314, circuit 5th, year 1991 Azar Nut Co. v. Comm., 91-1 USTC par. 50,257 (5th Cir., 1991) Volume 91-1 of the CCH USTC court reporter, paragraph 50,257, circuit 5th, year 1991 Azar Nut Co. v. Comm., 67 AFTR2d 91-987 (5th Cir., 1991) Volume 67 of the RIA AFTR2d court reporter, paragraph 91-987, year 1991

Primary Tax Authorities (4 of 5) Judicial Authorities: Citation: Explanation: U.S. Tax Court—Regular decision L.A. Beeghly, 36 TC 154 (1962) Volume 36 of the Tax Court reporter, page 154, year 1962 U.S. Tax Court—Memorandum decision Robert Rodriguez, RIA TC Memo 2005-012 Paragraph number 2005-012 of the RIA Tax Court Memorandum reporter Robert Rodriguez, 85 TCM 1162 (2005) Volume 85 of the CCH Tax Court Memorandum reporter, page 1162, year 2005 U.S. Court of Federal Claims J.R. Cohen v. U.S., 510 F. Supp. 297 (Fed. Cl., 1993) Volume 510 of the West F. Supp. court reporter, page 297, year 1993 J.R. Cohen v. U.S., 72 AFTR2d 93-5124 (Fed. Cl., 1993) Volume 72 of the RIA AFTR2d court reporter, paragraph 93-5124, year 1993 J.R. Cohen v. U.S., 93-1 USTC par. 50,354 (Fed. Cl., 1993) Volume 93-1 of the CCH USTC court reporter, paragraph 50,354, year 1993

Primary Tax Authorities (5 of 5) Judicial Authorities: Citation: Explanation: U.S. District Court Waxier Towing Co., Inc. v. U.S., 510 F. Supp. 297 (W.D. TN. 1981) Volume 510 of the West F. Supp. court reporter, page 297, Western District (W.D.), state Tennessee, year 1981 Waxier Towing Co., Inc. v. U.S., 81-2 USTC par. 9,541 (W.D., TN, 1981) Volume 81-2 of the CCH USTC court reporter, paragraph 9,541, Western District (W.D.), state Tennessee, year 1981 Waxier Towing Co., Inc. v. US., 48 AFTR2d 81-5274 (W.D., TN. 1981) Volume 48 of the RIA AFTR2d court reporter, paragraph 81-5274, Western District (W.D.), state Tennessee, year 1981

Secondary Tax Authorities (1 of 3) EXHIBIT 2-6 Common Secondary Tax Authorities Tax Research Services: BNA Tax Management Portfolios CCH Standard Federal Tax Reporter CCH Tax Research Consultant RIA Federal Tax Coordinator RIA United States Tax Reporter Newsletters: Daily Tax Report Federal Tax Weekly Alert Tax Notes

Secondary Tax Authorities (2 of 3) Law Reviews: Tax Law Review (New York University School of Law) Virginia Tax Review (University of Virginia School of Law) Professional Journals: Journal of Accountancy Journal of Taxation Practical Tax Strategies Taxes Tax Adviser

Secondary Tax Authorities (3 of 3) Quick Reference Sources: IRS Publications CCH Master Tax Guide RIA Federal Tax Handbook Textbooks: McGraw-Hill's Taxation of Individuals and Business Entities McGraw-Hill's Essentials of Federal Taxation

Tax Sources Are the following primary or secondary sources? Internal Revenue Code (Primary) Tax Article in USA Today (Secondary) Article on Supreme Court Opinion Supreme Court Opinion RIA Federal Tax Coordinator Treasury Regulations

Statutory Authorities U.S. Constitution The 16th Amendment provides Congress the ability to tax income directly, from whatever source derived, without apportionment across the states. Tax Treaties Agreements negotiated between countries that describe the tax treatment of entities subject to tax in both countries

Statutory Authority: Internal Revenue Code (1 of 2) The main statutory authority Changes enacted by Congress

Statutory Authority: Internal Revenue Code (2 of 2) Organization of Internal Revenue Code: Subtitle A – Income Taxes Chapter 1 – Income Taxes Subchapter A – Determination of Tax Liability Part I – Definition of Gross Income, Adjusted Gross Income, Taxable Income, etc. (Sec. 61 – 68) Sec. 61 – Gross Income Defined Sec. 62 – Adjusted Gross Income Defined Sec. 63 – Taxable Income Defined Subsection 63(c) – Standard Deduction Paragraph 63(c)(2) – Basic Standard Deduction Subparagraph 63(c)(2)(A) - … Clause 63(c)(2)(A)(i) - …

EXHIBIT 2-7 Tax Legislation Process

Judicial Sources: The Courts (1 of 2) Tasked with the ultimate authority to interpret the Internal Revenue Code and settle disputes between taxpayers and the IRS Supreme Court: the highest judicial authority; same authority level as the Internal Revenue Code Courts of Appeals: 13 circuit courts; the next level of judicial authority

Judicial Sources: The Courts (2 of 2) Trial-level courts: U.S. District Courts U.S. Court of Federal Claims U.S. Tax Court All courts apply the judicial doctrine of stare decisis, which means that a court will rule consistently with its previous rulings and the rulings of higher courts with appellate jurisdiction. The tax court applies the Golsen rule.

Administrative Sources: The U.S. Treasury (1 of 2) Regulations: Treasury Department’s official interpretation of the Internal Revenue Code 3 Different Forms: Final Temporary Proposed 3 Different Purposes: Interpretative Procedural Legislative

Administrative Sources: The U.S. Treasury (2 of 2) Revenue Rulings: Less authoritative weight, but they provide a much more detailed interpretation of the Code (e.g., application to a specific factual situation) Revenue Procedures: Explain in great detail IRS practice and procedures in administering tax law Letter Rulings: Less authoritative but more specific than revenue rulings and regulations (e.g., applied to a specific taxpayer)

Tax Research (1 of 3) Step 1: Understand facts Step 2: Identify issues Step 3: Locate relevant authorities Step 4: Analyze tax authorities Step 5: Document and communicate the results

Tax Research (2 of 3) Two types of tax services used in tax research: Annotated Topical Research questions often consist of questions of fact or questions of law. The answer to a question of fact hinges upon the facts and circumstances of the taxpayer’s transaction. The answer to a question of law hinges upon the interpretation of the law, such as interpreting a particular phrase in a code section.

Tax Research (3 of 3) When the researcher identifies that different authorities have conflicting views, she should evaluate the “hierarchy,” jurisdiction, and age of the authorities. Once the tax researcher has identified relevant authorities, she must make sure that the authorities are still valid and up to date.

Tax Memo Layout Facts Issues Authorities Conclusion Analysis

Client Letter Layout Salutation and social graces Research question and limitations Facts Analysis Closing

Tax Professional Responsibilities Tax professionals are subject to various statutes, rules, and codes of conduct. AICPA Code of Professional Conduct AICPA Statements on Standards for Tax Services IRS’s Circular 230 State board of accountancy statutes Failure to comply with statutes can result in being admonished, suspended, or barred from practicing.

Taxpayer and Tax Practitioner Penalties (1 of 2) Civil Penalties: most common type of penalties Generally in monetary penalties Imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause Criminal Penalties: much less common than civil penalties Penalties are much higher and can include prison sentences.

Taxpayer and Tax Practitioner Penalties (2 of 2) A taxpayer and tax practitioner will not be subject to an underpayment penalty if: There is substantial authority that supports the tax return position, or There is a reasonable basis for the position and it is disclosed on the taxpayer’s tax return.

End of Presentation